“I was walking along the road with two friends – the sun was setting – suddenly the sky turned blood red – I paused, feeling exhausted, and leaned on the fence – there was blood and tongues of fire above the blue-black fjord and the city – my friends walked on, and I stood there trembling with anxiety – and I sensed an infinite scream passing through nature.”

– Edvard Munch

“ ‘What’s happened to me,’ he thought. It was no dream.”

– Franz Kafka, The Metamorphosis

“Well, this is basically the end, so the answers should be in these next few pages. I doubt they will surprise you, but you never know. I don’t know how smart or thick you are. You could be Albert Einstein for all I know, or some literary prizewinner, or maybe you’re just middle of the road like me.”

– Markus Zusak, Underdog

“How could it happen, Grandad?”

The old man’s eyes misted over as he looked down at his grandson, who sat at his feet, his young eyes alive with questions as he turned the heavy gold bar over in his hands.

”I’ve told you the story too many times to count,” said the man, half-pleading, but knowing full-well he’d soon be deep into the umpteenth retelling of a story he’d lived through once in reality and a thousand times more through the eager questioning of the young man now tugging at his trouser leg. “Why don’t I tell you the story of how I met your Grandma instead?”

“Because that’s boring.” The reply was borne of the honesty only a ten-year-old could possibly still possess.

“OK, OK,” said the old man, a smile creeping into the corners of his mouth, “you win.”

“It began in early November of 2014, when a man called Alasdair Macleod published a report on how the Chinese had been secretly buying gold for 30 years.

“Most people believed what the Chinese Central Bank had been telling the world — that they owned just 1,054 tonnes. That number, first published in 2009, had remained unchanged for over five years; but there was a group of people who refused to accept that the People’s Bank of China were telling the truth, and those people set about diligently doing their own analysis to try to determine what the real number might be.

“In early November of 2014, Macleod’s report — which went largely unnoticed because most people were busy celebrating new highs in the stock market and the fact that a newly strengthening dollar was forcing down the price of gold — laid out the case for there having been an astounding amount of gold bought by the Chinese over the previous three decades.

“According to Macleod, China saw an opportunity at a crucial time and, with a view on the longer term, they took it.”

Grandad dipped his thumb and forefinger into his vPad, which hovered just above the table, and pinched and cast a paragraph into the air before them. At the same time, they heard the voice of Alasdair Macleod himself read the words aloud:

(Alasdair Macleod): China first delegated the management of gold policy to the People’s Bank by regulations in 1983. This development was central to China’s emergence as a free-market economy following the post-Mao reforms in 1979/82. At that time the west was doing its best to suppress gold to enhance confidence in paper currencies, releasing large quantities of bullion for others to buy.This is why the timing is important: it was an opportunity for China, a one-billion population country in the throes of rapid economic modernisation, to diversify growing trade surpluses from the dollar.

“Macleod explained why what he was about to explain to the world was going to come as something of a surprise to most people.” Grandad dipped his fingers and cast again:

To my knowledge this subject has not been properly addressed by any private-sector analysts, which might explain why it is commonly thought that China’s gold policy is a more recent development, and why even industry specialists show so little understanding of the true position. But in the thirty-one years since China’s gold regulations were enacted, global mine production has increased above-ground stocks from an estimated 92,000 tonnes to 163,000 tonnes today, or by 71,000 tonnes; and while the west was also reducing its stocks in a prolonged bear market all that gold was hoarded somewhere.

“But Grandad, why was the West selling its gold? That’s just stupid!” the young boy interjected, right on cue.

Again the old man smiled. Every time he told the story, his grandson would pepper him with the same questions, with a regularity that brought a familiar rhythm to this very private dance the two of them had performed so many times.

He paused, as he always did, to create just the right amount of dramatic tension before answering.

“I know it seems stupid NOW, but don’t forget, you know what you know. Back then, the people in charge in the West weren’t really all that smart; and, besides, when the Golden Domino finally fell, it became obvious that they had been...” — the old man paused, choosing his words carefully, almost theatrically; but when they came, they were the same carefully chosen words he used every time — “... a little less than honest about a few things.

“Now,” he continued with mock indignation, “if you’ll allow me to get back to the story...”

The boy smiled, and his grandfather pushed on.

“Macleod’s report concentrated on the period between 1983 and 2002, because in 2002 two important things happened: the Chinese people became free to own gold, and the Shanghai Gold Exchange was established. He wrote that the reason they allowed these two events to take place was that they’d already accumulated ‘enough gold’ for what he called ‘strategic and monetary purposes,’ and they were happy to keep adding to their stockpile from their domestic mine production and scrap, rather than buy more in the market...”

The old man held up a hand to head off the question he knew was coming — “I know, I know... you want to know how much the Chinese would have had to accumulate in order to be able to do this, don’t you? Well, Mr. Macleod told us, remember?” He reached once more into vPad space, waggled his fingers a bit, and cast the following:

(Alasdair Macleod) Between 1983 and 2002, mine production, scrap supplies, portfolio sales and central bank leasing absorbed by new Asian and Middle Eastern buyers probably exceeded 75,000 tonnes. It is easy to be blasé about such large amounts, but at today’s prices this is the equivalent of $3 trillion. The Arabs had surplus dollars and Asia was rapidly industrialising. Both camps were not much influenced by Western central bank propaganda aimed at side-lining gold in the new era of floating exchange rates, though Arab enthusiasm will have been diminished somewhat by the severe bear market as the 1980s progressed. The table and chart below summarise the likely distribution of this gold:

SIMPLIFIED GOLD SUPPLY 1983-2002

Tonnes

Official Sales by Central Banks

4,856

Estimated Leasing (Veneroso)

14,000

Mine Production

41,994

Net Western divestment (bullion, jewelry & scrap (est.)

15,000

TOTAL

75,850

The old man clipped his last sentence short to allow his young audience to make the (quite grown-up, the man thought) point that he always did at this juncture:

“But Grandad, you can’t just say things like ‘probable’ and make assumings like that. We always get told at school that you have to show your workings-out.”

His grandfather let the grammatical error slide — one more time.

“Ah yes, but THAT was the problem, wasn’t it? Everybody wanted proof that numbers like Macleod’s were accurate, but NOBODY wanted proof that the official figures were true, and THAT turned out to be the key lesson that the world learned from this whole sorry debacle.”

“But Grandad, YOU didn’t get hurt, did you?”

The old man looked through the window and out at the snowflakes settling on the tall pines that surrounded the ski field not 40 yards from where he sat, and smiled.

“That’s true,” he said, “but only because I was willing to think for myself and allow for possibilities that most people wouldn’t believe for a moment could actually happen. It wasn’t easy, and it wasn’t fun for many years, believe me. Now, where was I?”

“You were at the part where Mr. Macleod explained where all that gold had gone and...”

“Might have gone,” the man interrupted. “Remember, back then we didn’t know for sure.”

He smiled again and went on with the story.

“Macleod’s work suggested that, while a huge amount of gold had gone flooding into the Middle East during the oil boom of the 1970s (much of it ending up in Switzerland, which, back then at least, was famous around the world as being a safe haven for financial assets), in the mid-’90s, after the gold price had languished for many years, sentiment had changed.”

(Alasdair Macleod): In the 1990s, a new generation of Swiss portfolio managers less committed to gold was advising clients, including those in the Middle East, to sell. At the same time, discouraged by gold’s bear market, a Western-educated generation of Arabs started to diversify into equities, infrastructure spending and other investment media. Gold stocks owned by Arab investors remain a well-kept secret to this day, but probably still represent the largest quantity of vaulted gold, given the scale of petro-dollar surpluses in the 1980s. However, because of the change in the Arabs’ financial culture, from the 1990s onwards the pace of their acquisition waned.

By elimination this leaves China as the only other significant buyer during that era. Given that Arab enthusiasm for gold diminished for over half the 1983-2002 period, the Chinese government being price-insensitive to a Western-generated bear market could have easily accumulated in excess of 20,000 tonnes by the end of 2002.

“Now, I know this is all back-of-the-envelope stuff — assumings, as you call them — but remember, back then, in 2014, none of the other stuff had been exposed.”

“But, Grandad, why were the Chinese buying all that gold? And why did the Westerns let them have it? I mean, it’s worth so much. Why didn’t they just keep it?”

This was always the old man’s favourite part, and he leaned forward in his seat as his enthusiasm for the story returned. With a twinkle in his eyes, he beckoned the boy closer.

(WSJ, Oct 13, 2014): Russia and China have opened a currency-swap line, paving the way for further trade and investment between the neighboring countries, Russia’s central bank said on Monday.

The Bank of Russia and the People’s Bank of China agreed to open a yuan-ruble swap line worth 150 billion yuan ($24.47 billion or 984 billion rubles) for three years. This will offer both countries access to each other’s currencies without the need to purchase them on the currency markets, Russia’s central bank said.

(WSJ, Jul 21, 2014): The Swiss National Bank and People’s Bank of China have agreed to set up a currency swap line designed to boost trade and investment between the two countries, joining a parade of countries hoping to become offshore hubs for trading the yuan.

The Swiss and Chinese central banks said Monday that the three-year agreement will allow them to buy and sell their currencies up to a limit of 150 billion yuan, also known as renminbi, or 21 billion Swiss francs ($23.4 billion).

Such agreements mean the central banks can exchange currencies and firms can settle trade in local currencies rather than in US dollars.

The deal is one of the largest for China as it looks to build a more international role for the yuan.It will last for three years and can be extended if both parties agree.

“Strategy,” he said, then, after a pause (and with what even he felt was a little more relish than usual) “... and STUPIDITY!

“The Chinese had become very rich during those years, but most of that wealth had come in the form of dollars...”

“What, US dollars?” the boy asked, incredulously. “But why would they ever have wanted lots of those?”

“Because,” the old man chuckled, “there was a time — long before you were born — when everybody wanted US dollars. I know that’s hard to believe NOW, but it was true. If I may...?”

“So-rry Gran-dad,” the boy answered rhythmically and with mock apology.

“Anyway, the Chinese were great students of history and knew that, over thousands of years, what used to be called ‘fiat currency’ had always ended up worthless; and so they planned for the day when that fate would befall the dollar. They began accumulating euros instead of dollars — not because the euro was better but because they didn’t want to own too much of any one currency.”

“Whatever happened to the euro, Grandad?” inquired the boy.

“One story at a time, little fella!” replied the old man. “Now, where was I? Oh yes, then, in the mid-2010s, China began signing all sorts of agreements with other countries, like Iran, Turkey, Russia...”

“And Switzerland!” the boy eagerly interjected.

“... and Switzerland,” his grandfather agreed.

“Those agreements enabled them to swap goods and services for currencies other than the US dollar — all so they could eventually break their ties to what they saw as a doomed currency. And all the while, quietly, in the background, they were swapping as much of that paper money as they could for...?”

“GOLD!!!” Right on cue the boy blurted out the answer, raising both hands in triumph.

“Gold,” the old man said, softly. “Remember what Mr. Macleod wrote?” He cast it up:

(Alasdair Macleod): Following Russia’s recovery from its 1998 financial crisis, China set about developing an Asian trading bloc in partnership with Russia as an eventual replacement for Western export markets, and in 2001 the Shanghai Cooperation Organisation was born. In the following year, her gold policy also changed radically, when Chinese citizens were allowed for the first time to buy gold and the Shanghai Gold Exchange was set up to satisfy anticipated demand.

The fact that China permitted its citizens to buy physical gold suggests that it had already acquired a satisfactory holding.

Since 2002, it will have continued to add to gold through mine and scrap supplies, which is confirmed by the apparent absence of Chinese-refined 1 kilo bars in the global vaulting system. Furthermore China takes in gold doré from Asian and African mines, which it also refines and probably adds to government stockpiles.

Since 2002, the Chinese state has almost certainly acquired by these means a further 5,000 tonnes or more. Allowing the public to buy gold, as well as satisfying the public’s desire for owning it, also reduces the need for currency intervention to stop the renminbi rising. Therefore the Chinese state has probably accumulated between 20,000 and 30,000 tonnes since 1983, and has no need to acquire any more through market purchases, given her own refineries are supplying over 500 tonnes per annum.

“A man called Simon Hunt, who had extremely good connections in China and, more importantly perhaps, a willingness to entertain possibilities most people couldn’t, told a fascinating story once about a visit paid by a friend of his to an army base in China...”

(Simon Hunt, Nov 14, 2014): China is in the process of making the RMB acceptable as an international currency. It wants its trading partners and others to see the RMB as a stable currency that does not play the game of devaluation when difficulties arise. It is the long-game in which Beijing hopes that their currency not only becomes acceptable in financing trade but that central banks can feel secure in adding the RMB to their reserves, as some are now doing.

As we have discussed in earlier reports, China, not just the PBOC, holds far more gold than the market has been assuming, probably in the region of 30,000 tonnes, compared with the USA holding very little of its reported 8,300 tonnes.

Whilst in Japan we were told an interesting if not amusing story that supports this contention. A friend of ours has several factories in China and thus knows many senior people in different disciplines, one of which is a senior PLA officer. He was invited down to their HQ for drinks. After a few hours, his friend suggested they take a walk around the compound ending up at the entrance of a large warehouse. The door was opened and to my friend’s astonishment the warehouse was stacked from floor to ceiling with gold bars.

One day, when the timing suits Beijing best, the PBOC will link the RMB to gold. The West may dislike gold, or at least some of their central banks [do], preferring to operate with fiat currencies, but Eastern governments have a history of seeing gold as a store of value.

“NOW, of course, it seems that what Simon said should have been completely obvious; but all the way back in 2014, believe it or not, the idea that the Chinese would peg their currency to gold was something that most people here in the West just couldn’t even comprehend. I can’t even begin to tell you the number of times I talked to people about this stuff. For years it was obvious how things would end, but only a small group of people listened. Mostly, people just laughed and told me I was a fool. They said I should be buying shares and that a return to ANY kind of gold standard was a ridiculous idea. Do you know what I did?”

“Bought more gold?” The boy phrased it like a question even though he knew the answer. He just liked to let his grandfather have his moment.

“Bought more gold,” the old man said matter of factly. He threw up a chart they both knew well:

“But, but, you’ve jumped ahead, Grandad! The part where the Chinese link their currency to gold isn’t for ages yet. You skipped the bit about the Swiss gold! AND you left out the best part — the missing gold?”

“Sheesh!” the old man said in mock exasperation, “I’m coming to that part now! You are one impatient little fella, aren’t you?”

“But this is the best bit!” the boy replied excitedly.

“Well, if you’ll just stop interrupting...? Thank you! So... in November of 2014, the Swiss people had a referendum to decide whether the citizens of that once monetarily sound country wanted to take the first step towards returning to their historical position as a place where money actually meant something. Prior to the vote, some folks had warned of dirty tricks being used in the media to try to ensure the vote was a ‘No.’”

(Smaulgold): If Save Our Swiss Gold passes, the SNB would have to sell billions worth of Euro assets that they bought in recent years to support the 1.2 Swiss Franc to Euro peg in order to buy gold. Such an action would have a negative impact on the Euro.

As such … expect statements from central banks regarding the “danger” that Save Our Swiss Gold presents to the entire global monetary system... Expect the propaganda to be ratcheted up as November 30th approaches and to hear the terms “right-wing,” “far right” and “racist” bandied about in the mainstream media when discussing Save Our Swiss Gold, its sponsors and supporters...expect the SVP to be labelled “financial terrorists”...

“Well, this warning proved to be well-founded. This Reuters article (one of a number of such articles) ticked all the boxes...” The old man dipped again and again into v-space.

(Reuters): The “Save our Swiss gold” proposal, spearheaded by the right-wing Swiss People’s Party (SVP), aims to ban the central bank from offloading its reserves and oblige it to hold at least 20 percent of its assets in gold.... The SVP argues it would secure a stable Swiss franc....

The chairman of the SNB, which had already expressed its opposition to the proposal, said it would make it harder for the central bank to do its job.

“The initiative is not in Switzerland’s interest because it wants to fundamentally change the rules of our monetary policy,” Thomas Jordan was quoted as saying in Swiss newspaper Neue Zuercher Zeitung.

“It would be disastrous if Switzerland limited its own capabilities to react to disorder and maintain the stability of its currency.”The SNB also argues that Save our Swiss Gold could reduce the SNB’s annual profits that it distributes to Switzerland’s cantonal governments.

Fritz Zurbruegg, SNB board member warns “The higher the gold content, the smaller the income from interest or dividends,” he said.

“But some people,” the old man said, his voice taking on a defiant edge, “were having none of these arguments...”

(Smaulgold): This is a disingenuous argument, since the misguided goal of European banks is to reduce interest rates to zero or have them negative if possible, in order to boost inflation and economic growth. If the Save our Swiss Gold initiative were to pass, the loss in interest payments to the Swiss cantons would almost certainly be de minimus.

“Anyway, as the vote got closer, the dire ‘warnings’ from the establishment picked up steam — even though technically they weren’t supposed to be able to campaign. In a development that surprised nobody who followed the gold market closely and understood the various forces at work, the gold price fell like a stone from precisely the day the first poll — which showed significant support for the initiative — was published (after all, who would want to vote to hold more of something that was making headlines for falling in price?); and a few weeks later another poll was published that showed a suspiciously large swing from ‘Yes’ to ‘No’...”

(Marketwatch): Gold retreated on reports Wednesday that support for a Swiss referendum to require the country’s central bank to hold 20% of its reserves in gold bullions is losing momentum.

Only about 38% of those polled plan to vote for the Swiss gold measure, according to the Daily Mail, while Bloomberg reported that about 47% are likely to vote against it. The referendum, scheduled for Nov. 30, must secure more than 50% support to pass.

“Strangely, at the time, the comments sections of most online news sites in Switzerland were awash with pro-SGI sentiment. Anyway, that didn’t matter because the referendum passed with a clear majority, surprising the establishment and causing a massive tremor in gold and currency markets. It was that day which led indirectly to what they call the Golden Domino falling.”

“Tell me about the Golden Domino, Grandad!!”, said the boy, now unable to contain his excitement as his favourite part of the story approached.

“Well,” said the old man, relishing the tale and milking the tension for all it was worth (if dramatic tension were still possible in a story he’d told the young man so many times), “despite all the attempts to derail the Swiss gold vote, it passed; and the market had to react to the sudden realization that, not only was there now a buyer of 1,700 tonnes of gold in the market, but that same buyer had to defend an unlimited currency peg against the euro.

“The signs had been there in the run-up to the referendum, of course, but only a few people had been paying attention. People like Koos Jansen, who had been following the amount of gold leaving London, Hong Kong, and finally Switzerland for other countries. Koos saw the writing on the wall, and here’s his writing for you in the air...”

(Koos Jansen, Nov 20, 2014): From looking at rising SGE withdrawals and Indian import in recent months, we knew demand was increasing consistently and huge amounts of physical gold had to be supplied from somewhere. As I’ve written in a previous post, this type of gold demand can’t be met by mine supply and so the metal has to be sourced from countries that have large stockpiles, the usual suspects: the UK, Hong Kong and Switzerland.

In 2013 the UK was severely drained (net 1424 tonnes), last week we learned Hong Kong became a net exporter since August 2014, the latest trade data from Switzerland shows the Swiss net exported 100 tonnes of fine gold in October. 75 tonnes net to India and 45 tonnes net to China.

“Koos even told people that this couldn’t go on forever, but unfortunately very few people listened to him.”

Customs data of the usual suspects (Switzerland, the UK and Hong Kong) is getting exciting; they can’t net export gold forever. We know there are often shortages in these trading hubs, it’s only the price of gold that tells us otherwise. The Financial Times reported there are currently shortages in London, from November 14:

As one refiner told me: “Over the past four weeks my cost of hedging has risen by 30 per cent. Not only that, but there is not enough liquidity in the physical market in London to settle my obligations as they come due. I have to fly gold from Zürich to London, because there just is not enough gold on offer in London. You never used to have to do that.”

“Everybody focused on the fact that the Swiss would have to buy 1,700 tonnes of gold and tried to jump in front of the price, but nobody really worried about the repatriation of the Swiss gold — after all, it was only 312 tonnes — 104 held in Canada and 208 held at the Bank of England.”

“But Grandad...”

“Did you know I can read minds?” the old man asked mysteriously before the boy could finish his thought.

“No you can’t!” the boy exclaimed in the tone of a young child who’d heard similar outlandish claims from a grandparent one too many times.

“I can,” asserted his grandfather. “In fact, I know EXACTLY what you are thinking right NOW.”

“You are just about to say ‘But what about the German gold?’” said the old man casually, before settling back into his chair, enjoying the silence. It didn’t last long.

“No... I was... I was going to ask you about... something else,” the boy fumbled, “but you can tell me about that anyway. If you like.”

“Well the German Bundesbank, after getting just 5 of their 300 tonnes back from the Federal Reserve in 2013 and laying off their plans for repatriation, had a sudden change of heart. They decided they needed to get their hands on their gold as fast as they could. They knew the Swiss had no choice but to force repatriation, and they also knew that the more people they let in front of them in line, the smaller their chances were of ever getting their gold back.

“Nick Laird, the Australian Prime Minister, was an analyst back in those days who ran a website called Sharelynx. Like Koos, he was one of the few people paying close attention to what was going on. Nick published two charts right around the time of that Swiss referendum, showing that gold had once again begun to leave the Federal Reserve’s vault — something that had happened only twice in any size in the previous two decades: once right around the bursting of the NASDAQ bubble and the second time during what was then called the Great Recession, in 2008, but which we now know as...”

“The Great Head Fake!” Once more, the young man couldn’t help but interrupt, such was his excitement at the story as it unfolded

“The Great Head Fake, yes,” his grandfather patiently affirmed. “Nick’s charts showed that a few central bankers were maybe starting to get nervous and didn’t want to be the last ones looking for a chair — or in this case, their gold — when the music stopped.” He cast them up:

“Now, do you remember the difference between eligible gold and registered gold?” the old man asked his young charge, knowing the lad knew the answer but wanting to give him a chance to impress.

The boy sat bolt upright and recited, word for word, what he’d learned by rote at his grandfather’s knee: “Eligible gold is gold that meets exchange requirements but isn’t available for delivery, whilst registered gold is fully available to anybody who stands for delivery on the exchange,” he beamed.

“Bravo!” the old man said enthusiastically. “Well, on the COMEX the number of claims for every registered ounce had once again crept up to almost 60, whilst the mystery around why gold kept pouring out of one ETF as silver poured into another continued to baffle people.

“Anyway, right before the Swiss referendum, the Dutch, of all people, dropped another bombshell when they announced that they had, without making a fuss or telling ANYBODY, brought home 122.5 tonnes of gold from New York to Amsterdam.”

DNB Adjusts Gold Reserves Allocation Policy

Press release, date November 21, 2014.

De Nederlandsche Bank has adjusted its allocation policy for its gold reserves. To achieve a more balanced distribution of gold over the various locations, DNB has shipped gold from the US to the Netherlands.

In the old situation 11% of the gold reserves were located in the Netherlands, 51% in the US, with the remainder in Canada (20%) and the UK (18%). The location distribution according to the revised policy is as follows: 31% in Amsterdam, 31% in New York, while the percentages for Ottawa and London with 20 and 18% remain unchanged.

This adjustment of DNB joins other central banks that store a larger share of their gold reserves in their own country. Next to a more balanced distribution of the gold reserves over the different locations, this can also contribute to more trust towards the public.

“So, some people refer to that as the Golden Domino, while others point to 2016 when the EU broke apart after British Prime Minister Nigel Farage withdrew the UK and it was discovered that Greece and Spain had both been cooking the books again. That’s when Italy demanded their gold be repatriated, which of course led to a whole bunch of other countries doing the same thing.”

“Which one do you think was the Golden Domino, Grandad?” the boy asked.

“Me? Well personally I think the day Deputy Fed Chairman Jon Hilsenrath went before the cameras and announced that the Fed was refusing to repatriate any more gold and would settle in cash instead was the real Golden Domino. Some people said there were literally hundreds of claims on the gold supposedly held in safe custody, but we won’t know for sure how many there actually were until 2075, when the findings of the Krugman Commission are unsealed. I’ll be long gone by then, but at least you’ll get to find out — I hope.

“Of course, it was hardly a surprise that, with the gold price rising like a rocket, the Western central banks banned people from holding gold and capped the price; but that just played into China’s hands; and when the PBoC announced that they did, in fact, own not 25,000 tonnes of gold, as Mr. Macleod had estimated, but 38,000 tonnes, and that they were going to back the yuan with it, it was game over.”

“Dinner time, you two,” called a soft voice from across the expanse of the great room.

“But Grandma, we’re just getting to the bit where Grandad swaps one of his gold bars for this house!” the boy protested.

“Well I’m sure Grandad can tell you the rest of the story once you’re in bed. Goodness knows it’s the best way I can think of to put anybody to sleep.”

The boy’s grandmother winked at him as she put three steaming plates of stew on the table.

With mock indignation, the boy carefully put the gold bar back on his grandfather’s desk and headed towards the dining room. Behind him, his grandfather looked out of the window at the Chinese flag fluttering over the large gatehouse down the hill and smiled to himself as he hauled his weary body out of his comfortable but weathered armchair.

“How did it happen?” he mused to himself as he rose. “How could it not?”

Ending the greenback’s reserve-currency role will raise savings and make U.S. companies more competitive.

By Lewis E. Lehrman And John D. Mueller

Nov. 20, 2014 6:54 p.m. ET

For more than three decades we have called attention on this page to what we called the “reserve-currency curse.” Since some politicians and economists have recently insisted that the dollar’s official role as the world’s reserve currency is instead a great blessing, it is time to revisit the issue. The 1922 Genoa conference, which was intended to supervise Europe’s post-World War I financial reconstruction, recommended “some means of economizing the use of gold by maintaining reserves in the form of foreign balances”—initially pound-sterling and dollar IOUs. This established the interwar “gold exchange standard.”A decade later Jacques Rueff, an influential French economist, explained the result of this profound change from the classical gold standard. When a foreign monetary authority accepts claims denominated in dollars to settle its balance-of-payments deficits instead of gold, purchasing power “has simply been duplicated.” If the Banque de France counts among its reserves dollar claims (and not just gold and French francs)—for example a Banque de France deposit in a New York bank—this increases the money supply in France but without reducing the money supply of the U.S. So both countries can use these dollar assets to grant credit. “As a result,” Rueff said, “the gold-exchange standard was one of the major causes of the wave of speculation that culminated in the September 1929 crisis.” A vast expansion of dollar reserves had inflated the prices of stocks and commodities; their contraction deflated both.The gold-exchange standard’s demand-duplicating feature, based on the dollar’s reserve-currency role, was again enshrined in the 1944 Bretton Woods agreement. What ensued was an unprecedented expansion of official dollar reserves, and the consumer price level in the U.S. and elsewhere roughly doubled. Foreign governments holding dollars increasingly demanded gold before the U.S. finally suspended gold payments in 1971. The economic crisis of 2008-09 was similar to the crisis that triggered the Great Depression.This time, foreign monetary authorities had purchased trillions of dollars in U.S. public debt, including nearly $1 trillion in mortgage-backed securities issued by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The foreign holdings of dollars were promptly returned to the dollar market, an example of demand duplication. This helped fuel a boom-and-bust in foreign markets and U.S. housing prices. The global excess credit creation also spilled over to commodity markets, in particular causing the world price of crude oil (which is denominated in dollars) to spike to $150 a barrel.Perhaps surprisingly, given Keynes ’s central role in authoring the reserve-currency system, some American Keynesians such as Kenneth Austin, a monetary economist at the U.S. Treasury; Jared Bernstein, an economic adviser to Vice President Joe Biden ; and Michael Pettis, a Beijing-based economist at the Carnegie Endowment, have expressed concern about the growing burden of the dollar’s status as the world’s reserve currency. For example, Mr. Bernstein argued in a New York Times op-ed article that “what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles.” He urged that, “To get the American economy on track, the government needs to drop its commitment to maintaining the dollar’s reserve-currency status.”Meanwhile, a number of conservatives, such as Bryan Riley and William Wilson at the Heritage Foundation, James Pethokoukis at the American Enterprise Institute and Ramesh Ponnuru at National Review are fiercely defending the dollar’s reserve-currency role. Messrs. Riley and Wilson claim that “The largest benefit has been ‘seignorage,’ which means that foreigners must sell real goods and services or ownership of the real capital stock to add to their dollar reserve holdings.” This was exactly what Keynes and other British monetary experts promoted in the 1922 Genoa agreement: a means by which to finance systemic balance-of-payments deficits, forestall their settlement or repayment and put off demands for repayment in gold of Britain’s enormous debts resulting from financing World War I on central bank and foreign credit. Similarly, the dollar’s “exorbitant privilege” enabled the U.S. to finance government deficit spending more cheaply. But we have since learned a great deal that Keynes did not take into consideration. As Robert Mundell noted in “Monetary Theory” (1971), “The Keynesian model is a short run model of a closed economy, dominated by pessimistic expectations and rigid wages,” a model not relevant to modern economies. In working out a “more general theory of interest, inflation, and growth of the world economy,” Mr. Mundell and others learned a great deal from Rueff, who was the master and professor of the monetary approach to the balance of payments. Those lessons are reflected in the recent writings of Keynesians such as Mr. Austin, who has outlined what he calls the “iron identities” of international payments, which flow from the fact that global “current accounts, global capital accounts, and global net reserve sales, must (and do) sum to zero.” This means that a trillion-dollar purchase, say, of U.S. public debt by the People’s Bank of China entails an equal, simultaneous increase in U.S. combined deficits in the current and capital accounts. The iron identities necessarily link official dollar-reserve expansion to the declining U.S. investment position.The total U.S. international investment position declined from net foreign assets worth about 10% of gross domestic product in 1976 to minus-30% of GDP in 2013—while the books of U.S. private residents went from 10% of U.S. GDP in 1976 down to balance with the rest of the world in 2013. The entire decline in the U.S. net international investment position was due to federal borrowing from foreign monetary authorities—i.e., government deficit-financing through the dollar’s official reserve-currency role.Ending the dollar’s reserve-currency role will limit deficit financing, increase net national savings and release resources to U.S. companies and their employees in order to remain competitive with the rest of the world. Messrs. Riley and Wilson argue that “no other global currency is ready to replace the U.S. dollar.” That is true of other paper and credit currencies, but the world’s monetary authorities still hold nearly 900 million ounces of gold, which is enough to restore, at the appropriate parity, the classical gold standard: the least imperfect monetary system of history.

Six years ago the Federal Reserve hit rock bottom. It had been cutting the federal funds rate, the interest rate it uses to steer the economy, more or less frantically in an unsuccessful attempt to get ahead of the recession and financial crisis. But it eventually reached the point where it could cut no more, because interest rates can’t go below zero. On Dec. 16, 2008, the Fed set its interest target between 0 and 0.25 percent, where it remains to this day.

The fact that we’ve spent six years at the so-called zero lower bound is amazing and depressing. What’s even more amazing and depressing, if you ask me, is how slow our economic discourse has been to catch up with the new reality. Everything changes when the economy is at rock bottom — or, to use the term of art, in a liquidity trap (don’t ask). But for the longest time, nobody with the power to shape policy would believe it.

What do I mean by saying that everything changes? As I wrote way back when, in a rock-bottom economy “the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.” Government spending doesn’t compete with private investment — it actually promotes business spending. Central bankers, who normally cultivate an image as stern inflation-fighters, need to do the exact opposite, convincing markets and investors that they will push inflation up. “Structural reform,” which usually means making it easier to cut wages, is more likely to destroy jobs than create them.

This may all sound wild and radical, but it isn’t. In fact, it’s what mainstream economic analysis says will happen once interest rates hit zero. And it’s also what history tells us. If you paid attention to the lessons of post-bubble Japan, or for that matter the U.S. economy in the 1930s, you were more or less ready for the looking-glass world of economic policy we’ve lived in since 2008.

But as I said, nobody would believe it. By and large, policy makers and Very Serious People in general went with gut feelings rather than careful economic analysis. Yes, they sometimes found credentialed economists to back their positions, but they used these economists the way a drunkard uses a lamppost: for support, not for illumination. And what the guts of these serious people have told them, year after year, is to fear — and do — exactly the wrong things.

Thus we were told again and again that budget deficits were our most pressing economic problem, that interest rates would soar any day now unless we imposed harsh fiscal austerity. I could have told you that this was foolish, and in fact I did, and sure enough, the predicted interest rate spike never happened — but demands that we cut government spending now, now, now have cost millions of jobs and deeply damaged our infrastructure.

We were also told repeatedly that printing money — not what the Fed was actually doing, but never mind — would lead to “currency debasement and inflation.” The Fed, to its credit, stood up to this pressure, but other central banks didn’t. The European Central Bank, in particular, raised rates in 2011 to head off a nonexistent inflationary threat. It eventually reversed course but has never gotten things back on track. At this point European inflation is far below the official target of 2 percent, and the Continent is flirting with outright deflation.

But are these bad calls just water under the bridge? Isn’t the era of rock-bottom economics just about over? Don’t count on it.

It’s true that with the U.S. unemployment rate dropping, most analysts expect the Fed to raise interest rates sometime next year. But inflation is low, wages are weak, and the Fed seems to realize that raising rates too soon would be disastrous. Meanwhile, Europe looks further than ever from economic liftoff, while Japan is still struggling to escape from deflation. Oh, and China, which is starting to remind some of us of Japan in the late 1980s, could join the rock-bottom club sooner than you think.

So the counterintuitive realities of economic policy at the zero lower bound are likely to remain relevant for a long time to come, which makes it crucial that influential people understand those realities. Unfortunately, too many still don’t; one of the most striking aspects of economic debate in recent years has been the extent to which those whose economic doctrines have failed the reality test refuse to admit error, let alone learn from it. The intellectual leaders of the new majority in Congress still insist that we’re living in an Ayn Rand novel; German officials still insist that the problem is that debtors haven’t suffered enough.

This bodes ill for the future. What people in power don’t know, or worse what they think they know but isn’t so, can very definitely hurt us.

Dissatisfaction abounds in policy circles and among respected economic commentators (like Martin Wolf and Paul Krugman) about the weak and patchy recovery in global GDP which has been underway since 2009. Rightly so. At minimum, Japan and the euro area seem to be mired in secular stagnation.Yet the financial markets do not seem to share this global pessimism. Although there was a brief growth scare in the equity markets in October, this vanished almost immediately, and markets are again in optimistic mode.Are the markets living in a parallel universe, or are they smelling a near term improvement in global GDP growth?In recent days, the 2014 oil shock has induced central banks to ease monetary conditions further. Admittedly, many analysts think that monetary policy is now firing blanks. But lower oil prices, if maintained, will themselves boost global GDP by 0.5-1.5 percent next year. Furthermore, the global fiscal drag that has dampened the recovery in the past four years has now virtually disappeared. It may not be enough to spell the end to secular stagnation, but the new policy mix should point to a somewhat better year for growth in the developed economies in 2015 – perhaps even in the euro area, where pessimism has recently become quite extreme..

It is now accepted by most economists that the repeated disappointments in global growth projections since 2010 have occurred because aggregate demand has fallen short even of the sluggish growth in potential GDP, in each successive year. Global economic policy has not been able to sustain demand growth at the rate required to stabilise inflation at the 2 per cent target in most economies.This is sobering, in view of the unprecedentedly expansionary monetary policy that has been in place since the crash. But aggressive action by the central banks has been unable to offset fully the tightening in fiscal policy that all the major economies have embarked upon since 2010. The easy monetary/tight fiscal stance has emerged everywhere, though with somewhat different timing from one major economy to another. Its success has been limited:

The graph above shows some broad brush measures of the overall stance of fiscal and monetary policy in the major developed economies since the crash1, and also the rate of growth in GDP relative to potential.There have been three phases of policy:

• From 2008-09, both fiscal and monetary policy were eased simultaneously, in order to soften the crash. This worked to some extent, leading to above trend growth in 2010.

• From 2010-14, initially encouraged by the IMF and the G20, policy embarked on a period of fiscal consolidation, and the central banks moved into a second phase of quantitative easing. This did not result in a robust recovery in GDP. In fact, growth was generally stuck at or below potential in this phase and, time after time, initially optimistic economic forecasts had to be revised sharply downwards.• The third phase started to take shape in 2014. Fiscal authorities, probably accepting that budget multipliers have proven higher than they expected during the second phase, have shifted a long way from austerity towards neutrality. This was led by the US and the UK but is now being followed by Japan and even the euro area. Central banks, however, have not responded to this shift by withdrawing monetary support. True, the Federal Reserve and the Bank of England have halted QE, but the Bank of Japan and the ECB have stepped into the breach. The overall rate of global central bank balance sheet expansion is actually accelerating.How confident can we be that the third phase – monetary expansion and fiscal neutrality – will prove significant and durable?

On the fiscal side, there is little doubt that the US and Japan have now stopped tightening budgetary policy for at least a couple of years. In the euro area, the originally planned tightening in 2014 and 2015 has also now been replaced by a neutral stance, due to delayed consolidation in France and Italy.More surprisingly, there is market chatter that some Anglo-Saxon policy makers returned from the G20 meetings in Australia last weekend speculating that the fiscal policy stance in the euro area might even be eased in the next year or two. Reportedly, they were optimistic that the Juncker plan for €300 billion of extra investment will have some substance, and that the gap before this plan takes effect could even be filled with an emergency fiscal easing of (say) 1 per cent of GDP in 2015 and 2016.This sounds improbable, based on what is being said in public, but the Germans might conceivably have decided that a controlled fiscal easing in the euro area would be preferable to open-ended purchases of sovereign debt by the ECB, which they would not fully control. We may discover more at the next European summit on 18-19 December.Turning to global monetary policy, the oil shock is clearly having a major impact on central bank thinking. Initially, many economists said that central banks would “look through” the decline in headline inflation, because core inflation would not be changing. In fact, however, they have shown themselves to be very worried that the drop in headline inflation will, this time, unhinge inflation expectations, increasing the risk of getting stuck in a deflation trap.The Bank of Japan moved first, attributing its latest monetary easing directly to the effects of lower oil prices. On Friday, ECB President Draghi, in his most explicitly dovish speech ever, said that inflation expectations are “excessively low” and that reported inflation must be raised “without delay … as fast as possible”. Lower oil prices seems to have increased his sense of urgency considerably. Even the Federal Reserve, which is normally very resistant to placing too much emphasis on headline inflation rates, seems concerned about persistent “lowflation”.Finally, the interest rate cuts by the People’s Bank of China on Friday may not be a big deal in themselves, but they do suggest that the drop in headline inflation will lead to generally lower rates in the emerging world as well. Apart from lower inflation, the exchange rate effects triggered by monetary easing in Japan and the euro area are causing many other countries to act.So the oil shock is directly boosting global growth, and is also triggering a further major monetary easing, just as fiscal tightening is becoming neutral. Without engaging in irrational exuberance, it seems quite possible that, for the first time in half a decade, global growth forecasts for 2015 will need to be revised upwards, not downwards.[1] The forecasts for 2015-16 are estimates by the author based on latest policy announcements in the major economies.

We are in a "multi-year phase of a US dollar recovery" and markets are underestimating the power of the trend

By Ambrose Evans-Pritchard, International Business Editor

4:52PM GMT 20 Nov 2014

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Pound heading to €1.54 by 2017, according to the US investment bankPhoto: Joe Partridge/Rex Features

Sterling is to climb relentlessly against the euro over the next three years and will reach levels last seen at the turn of the century, according to new forecasts by Goldman Sachs.

The US investment bank said the dollar will rise even faster as the American economy powers ahead and interest rates rise steeply, touching parity against the euro and climbing to 140 Japanese yen. The Brazilian real will tumble to 3.10 as the commodity boom continues to deflate.

“We are in a multi-year phase of a US dollar recovery. The market may be underestimating the scope and persistence of that trend,” it said.

The euro will drop to 0.65 against the pound by 2017, driven by capital inflows rather than trade effects. This approaches levels seen in the period from 1999-2002 when Germany’s economy fell into a deep slump and the Neuer Markt for hi-tech stocks collapsed. This is a dramatic revision since the bank’s previous forecast was 0.85. “Euro downside remains our top conviction view,” it said.

Goldman Sachs said the European Central Bank is still reluctant to buy sovereign bonds and launch full-blown quantitative easing but is likely to act more aggressively than markets expect when it finally does. On an inverted basis, UK exchange rate would be €1.54 to the pound by 2017. This turn would Europe into a cheap region for holidays once again, and offer bargain basement prices for farmhouses in Tuscany or Aquitaine. Yet such a dramatic rise in sterling cannot easily be justified by the underlying weakness of the British economy, which already has the worst current account deficit in the developed world. It was running at 5.2pc of GDP in the second quarter. While part of this deficit is due to the economic relapse in the eurozone, it also suggests that the exchange rate is badly overvalued even at current levels. The International Monetary Fund estimates that the pound is 5pc to 10pc too strong.

The exchange rate follows the divergence in Interest rates

Cumulative inflation in the UK has been much higher than in the eurozone, without any improvement in relative productivity. A return to the euro-sterling exchange rate of fifteen years ago would imply a massive overvaluation, and could push the UK deficit towards 7pc of GDP. “The current account deficit is probably the worst in history,” said David Bloom from HSBC. “We have only three problems with sterling: cyclical, structural, and political; and we don’t really believe in this recovery.” “We think that whatever infects the eurozone also infects Britian. They feed into each other and that is why we think sterling will go down with the euro. The dollar is the only rose between these two thorns,” he said..Euro/Sterling rate for the last 20 years

The Goldman Sachs forecasts were contained in its predictions for 2015, a list that includes a “New Oil Order” as extra crude supply from Libya, Iraq, and Iran pushes prices even lower. The bank said the US Federal Reserve will not raise rates until September of next year, later than the markets expect. But it will then move faster and on a steeper trajectory than widely assumed as it tries return to a “neutral” rate of 4pc. The report insists that this will be “manageable” for the world, invoking the curious argument that bond tapering has so far been benign and that Fed tightening will therefore continue to be so in the future.

The analysis of Fed policy almost certainly reflects the broad outlook of William Dudley, a Goldman Sachs economist before he became head of the New York Fed. He is one of the most influential figures on the voting committee. Mr Dudley’s views have tended to prevail over recent meetings and are tracked closely by analysts. The latest Fed minutes played down concerns about the strength of the dollar, suggesting that the closed nature of the US economy makes it resilient against an exchange rate shock.

Goldman Sachs said the US economic expansion has “several years to run” and will drive another long phase of global growth. The S&P 500 index of Wall Street stocks will rise to 2,300 by 2017, the Stoxx Europe 600 index will rise to 440, and the Japanese Topix wil hit 1,900, so bask in sunlit uplands and enjoy. Gold will go nowhere.

Buying a house is not just a big deal, it’s the biggest. Marriage and children may bring more happiness – or misery, if you’re unlucky – but few of us will ever sign a bigger cheque than the one that buys that big pile of bricks, mortar and dry rot.

It would be nice to report that buyers and sellers are paragons of rationality, and the housing market itself a well-oiled machine that makes a sterling contribution to the working of the broader economy. None of that is true. House buyers are delusional, the housing market is broken and a housing boom is the economic equivalent of a tapeworm infection.As a sample of the madness, consider the popular concept of “affordability”. This idea is pushed by the UK’s Financial Conduct Authority and seems simple common sense: affordability asks whether potential buyers have enough income to meet their mortgage repayments. That question is reasonable, of course – but it is only a first step, because it ignores inflation.

To see the problem, contrast today’s low-inflation economies with the high inflation of the 1970s and 1980s. Back then, paying off your mortgage was a sprint: a few years during which prices and wages were increasing in double digits, while you struggled with mortgage rates of 10 per cent and more. After five years of that, inflation had eroded the value of the debt and mortgage repayments shrank dramatically in real terms.Today, a mortgage is a marathon. Interest rates are low, so repayments seem affordable. Yet with inflation low and wages stagnant, they’ll never become more affordable. Low inflation means that a 30-year mortgage really is a 30-year mortgage rather than five years of hell followed by an extended payment holiday. The previous generation’s rules of thumb no longer apply.Because you are a sophisticated reader of the Financial Times you have, no doubt, figured all this out for yourself. Most house buyers have not. Nor are they being warned. I checked a couple of the most prominent online “affordability” calculators. Inflation simply wasn’t mentioned, even though in the long run it will affect affordability more than anything else.This isn’t the only behavioural oddity when it comes to housing markets. Another problem is what psychologists call “loss aversion” – a disproportionate anxiety about losing money relative to an arbitrary baseline. I’ve written before about a study of the Boston housing crash two decades ago, conducted by David Genesove and Christopher Mayer. They found that people who bought early and saw prices rise and then fall were realistic in the price they demanded when selling up. People who had bought late and risked losing money tended to make aggressive price demands and failed to find buyers. Rather than feeling they had lost the game, they preferred not to play at all. The housing market also interacts with the wider economy in strange ways. A study by Indraneel Chakraborty, Itay Goldstein and Andrew MacKinlay concludes that booming housing markets attract bankers like jam attracts flies, sucking money away from commercial and industrial loans. Why back a company when you can lend somebody half a million to buy a house that is rapidly appreciating in value? Housing booms therefore mean less investment by companies. . . .

House prices have even driven the most famous economic finding of recent years: Thomas Piketty’s conclusion (in joint work with Gabriel Zucman) that “capital is back” in developed economies. Piketty and Zucman have found that relative to income, the total value of capital such as farmland, factories, office buildings and housing is returning to the dizzy levels of the late 19th century.

But as Piketty and Zucman point out, this trend is almost entirely thanks to a boom in the price of houses. Much depends, then, on whether the boom in house prices is a sentiment-driven bubble or reflects some real shift in value. One way to shed light on this question is to ask whether rents in developed countries have boomed in the same way as prices. They haven’t: research by Etienne Wasmer and three of his colleagues at Sciences Po shows that if we measure the value of houses using rents, there’s no boom in the capital stock.The housing market then, is prone to bubbles and bouts of greed and denial, is shaped by financial rules of thumb that no longer apply, and sucks the life out of the economy. It even muddies the waters of the great economic debate of our time, about the economic significance of capital.One final question, then: is it all a bubble? That is too deep a question for me but there is an intriguing new study by three German economists, Katharina Knoll, Moritz Schularick and Thomas Steger. They have constructed house-price indices over 14 developed economies since 1870. The pattern is striking: about 50 years ago, real prices started to climb inexorably and at an increasing rate. If this is a bubble, it’s been inflating for two generations.At least dinner-party guests across London will continue to have something to bore each other about. Not that anybody will be able to afford a dining room.

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.